Many actors return from the first film to respectively reprise their roles. Steve Guttenberg reprises his role as Mahoney, the class clown; former American football player Bubba Smith returns as the man-mountain Hightower; Marion Ramsey is featured again as Laverne Hooks; David Graf returns as gun-crazy Officer Eugene Tackleberry; Michael Winslow returns as sound effects wizard Officer Larvell Jones, and veteran actor George Gaynes returns as Commandant Eric Lassard. This was the only film in the series that does not feature Leslie Easterbrook as Lt. Debbie Callahan.

New faces in Police Academy 2 include Howard Hesseman as Captain Pete Lassard (the brother of Police Academy commandant Eric Lassard), Bobcat Goldthwait as Zed, the leader of "The Scullions", an obnoxious gang, Art Metrano as Lt. Mauser, Peter Van Norden as slobbish police dog sergeant Vinnie, Tim Kazurinsky as hapless business owner Carl Sweetchuck, and Lance Kinsey as Sgt. Proctor. In the film, the Police Academy cadets have graduated and are assigned to the worst precinct in town, where they have to help Captain Pete Lassard fight Zed's gang.

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After a random attack the night before by a local gang known as "The Scullions" and their infantile leader Zed McGlunk (Bobcat Goldthwait), Chief Henry Hurst (George R. Robertson) arrives at the 16th precinct and notifies its captain, Pete Lassard (Howard Hesseman) that the precinct is the worst in the city. Lassard protests saying that his officers are outmanned and old, and can't get the job done any longer. Nevertheless, Hurst gives Lassard 30 days to turn the precinct around or he is out. Before Hurst leaves, Lieutenant Mauser (Art Metrano) schemes his way into getting a promotion to Captain should Lassard fail. Capt. Lassard then calls his brother Eric (George Gaynes) who is in charge of the Police Academy and asks him for six new recruits. Mauser is seen talking with his dim-witted partner, Sgt. Proctor (Lance Kinsey), as he attempts to take control of the precinct.

Mauser attempts numerous times to sabotage the new recruits while personally targeting Mahoney. During a patrol, Mahoney and Schtulman spot a robbery at a merchant's place, but the robbers escape in the confusion caused in part by responding officers. Mauser is ready to suspend them, but Mahoney makes a passionate plea that convinces Lassard to give them another chance. While all this is going on, Zed and his gang go "shopping" in a supermarket, causing havoc and chaos.

Mauser gives Mahoney a new assignment: patrolling a tunnel which results in him and his partner being covered with soot. He gets revenge on Mauser by switching his shampoo with Tackleberry's epoxy resin solution from a helmet repair kit, which glues Mauser's hands to his hair. He ends up embarrassing himself in front of the station and has to wear a wig through the remainder of the film. Capt. Lassard spots some of Zed's men and tries to deal with them, but is over-powered and spray-painted. This humiliating act emboldens Lassard to allow the precinct to use "whatever means possible" to help contain the gang. Progress is made and most of the gang is captured in an incident at The Blue Oyster Bar, but Mauser informs the captain that he had most of the charges dropped due to excessive force and procedure violations. Mahoney sees that Mauser did this on purpose, so as revenge he informs the nurse in charge of a body cavity search ordered earlier to perform the procedure on Mauser.

Later, Tackleberry goes on a date with Kirkland, where they stay out late dancing. They profess their love for each other and they make love (after removing their numerous concealed weapons first before). Captain Lassard goes to see his brother Eric at a Japanese steakhouse and Eric comes up with an idea to hold a fair. On the night of the fair though, Zed's men trash the place. Lassard is out of a job the next day, while Mauser is promoted to captain. His first act is to remove Mahoney and Schtulman, who is quick to object to Mahoney's dismissal.

Mahoney, Schtulman, and Lassard get together in a last-ditch attempt to stop the gang. They send in Mahoney undercover to infiltrate the gang. Lassard and Schtulman wire him, using duct tape and a radio microphone. Under the guise of "Jughead," formerly of the gang "The Archies", he is able to infiltrate the gang and find out both their hiding spot and the name of their leader. However, his cover is blown after the microphone cuts into a radio ad, which leads to Captain Lassard calling every man to the location. The officers arrive, but are stopped by Mauser. Mauser attempts to conduct a raid, but Fackler accidentally bumps him in an air duct and pushes him inside, which leads to Mauser being captured by Zed and his gang. The officers stage their own raid and manage to overpower and arrest the gang. Zed attempts to escape with Mahoney, but Lassard blocks his escape and prepares to shoot Zed. However, Mahoney punches Zed down a flight of stairs, where Hooks arrests him. It's then revealed that Lassard's gun wasn't loaded, as he "hasn't carried live ammo since '73". Lassard is later reinstated as captain, as are Mahoney and Schtulman on the force, while Mauser demoted back to lieutenant for nearly blowing Lassard's raid.

The film ends with the officers (including the re-instated Lassard) attending Tackleberry and Kirkland's wedding. They drive off the police academy lot in the monster truck Bigfoot.